Contango Shrinks But Oil Meets Resistance At $46

Friday, May 13, 2016

In the latest edition of the Numbers Report, we'll take a look at some of the most interesting figures put out this week in the energy sector. Each week we'll dig into some data and provide a bit of explanation on what drives the numbers.

Let's take a look.

1. Despite plunging LNG prices, industry dictated by long-term contracts

- The LNG industry is going through a bust that rivals the collapse of crude oil prices. LNG spot prices are down three-quarters from a peak two years ago. Part of that is due to the influence of falling oil prices, but also because of surging supply and weak demand.
- Despite that, the industry is still dominated by long-term contracts. Bloomberg notes that less than 15 percent of the long-term contracts in the global LNG industry will expire before 2020. In other words, buyers have locked themselves into higher prices for years to come, making it difficult to benefit from low prices.
- While this may seem like good news for LNG exporters, prices have dropped so low - $4.24/MMBtu for June delivery - that purchasers are getting restless, demanding contract renegotiations.
- Qatar has already acquiesced to renegotiation, agreeing to cut prices in half for Petronet LNG. This has other buyers, notably China's CNPC, demanding price reductions as well.
- The trend is clear - LNG markets are destined to transform, increasingly relying on spot prices rather than long-term contracts. Also, LNG prices will be set by supply and demand fluctuations rather than basing prices on a link to crude oil. This will be possible because of increasing liquidity in the LNG market (no pun intended).
- But before we get there, there could be a lot of haggling and fighting over the existing long-term contracts.

2. The shrinking of the market contango

- The oil price rally that occurred between February and April saw the market contango shrink. The contango measures the discount between month-ahead contracts and oil deliveries in the future. A contango tends to reflect oversupply in the short run.
- But the contango narrowed as production levels declined, easing concerns about a short-term glut. In early May, the contango stopped shrinking, as the oil price rally stalled, but remained near its narrowest level since last summer.
- The contango probably won't widen again as global production levels, particularly from the U.S., continue to fall. A narrow contango will make storing crude oil for sale at a later date no longer profitable. As a result, inventories should start to fall, putting upward pressure on prices.
- Of course, that line of argument could be read in the reverse direction: production is falling, so storage should start to fall, easing concerns about a near-term glut. As a result, the contango should continue to shrink.
- Either way, the trend is clear: oil prices should start to rise and the sharp contango is probably over.

3. Oil price volatility down

- Anyone paying attention to the oil markets would know that oil prices have been extremely volatile over the past year. In January, oil price volatility flared up as WTI and Brent crashed to their lowest levels in years.
- The EIA defines volatility as the standard deviation of daily percent changes in crude prices over the previous 30 trading days. Volatility rose to 45 percent at on March 4, which was the highest point since the financial crisis in 2009. By late April, volatility fell to 33 percent, which was still higher than the 2015 average of 27 percent.
- By May, daily fluctuations have calmed a bit. That is because the future looks much clearer than it did a few months ago: the U.S. is posting steady declines in output each week, fears over global economic growth have eased, and demand has grown at a steady pace.
- There is still a lot of uncertainty, but the first quarter of 2016 will probably go down as the most volatile in a long time.

4. Resistance at $46

- Oil prices have formed a "double top," a bearish technical pattern that forms after a price hits two peaks and fails to rise above a given resistance level.
- The pattern is discernable by a rising price trend beforehand, a first peak, a 10 to 20 percent reversal, a second peak and then a reversal.
- WTI is showing resistance at $46 right now, trying and failing so far to substantially break through that threshold.
- Major supply outages in Nigeria and Canada have not caused prices to spike above $46.
- Technical trading theories are never guaranteed, but the double top suggests that oil prices could fall back having failed to break through the peak.

5. Balance just a few months away

- In its latest Oil Market Report, the IEA sticks with its prediction that oil supply and demand will converge in the second half of 2016.
- The agency estimates that supply exceeds demand by 1.3 million barrels per day in the first of the year, but sharply narrows to a small 0.2 mb/d surplus in the third and fourth quarters.
- The estimate is largely unchanged from previous forecasts, even though the oil markets have been rife with unexpected events. The IEA says Iran is ramping up output much faster than expected, while that higher supply has been offset with outages in Nigeria, Canada, and Venezuela.
- Storage levels remain very high, but in the first quarter of 2016 they grew at their slowest pace since 2014. High inventories will slow any price rise, but the markets should very soon begin to start drawing down those stockpiles.

6. Natural gas storage levels at a seasonal high

- Natural gas inventories sat at 2,625 billion cubic feet at the end of April, 49 percent higher than last year. The massive buildup has occurred because of record natural gas production, combined with warm temperatures from an El Nino winter.
- Weak winter demand means that the current "injection season" could take inventories to 4,158 Bcf by October, which the EIA says will be a record high for that time of year.
- But this is not guaranteed. Natural gas production has actually peaked and begun to decline, because prices have dropped so low.
- Rig counts are at their lowest levels in more than two decades, which means production should continue to decline as wells deplete. For now, prices wallow at around $2 per MMBtu, which could last for quite a while. But prices should gradually rise as production falls.
- By next year, inventories should fall back to average levels.

7. India the "star performer"

- The IEA said that India is now the "star performer" in global oil markets, with oil consumption up 400,000 barrels per day in the first quarter of 2016 from a year earlier.
- That accounted for 30 percent of the entire global increase in oil consumption over the past year.
- The increase was enough to put India's consumption over the 4 mb/d mark for the first time over a 12-month period ending in April. With consumption averaging 4.4 mb/d in the first quarter, India has surpassed Japan to become the world's third largest oil consumer.
- India is now much more important for demand growth than China. While the executives from oil, gas, coal, and other commodity producing companies had China at the top of their list when considering capacity expansions over the past decade, in the future India will be at the core of any demand scenario.

That's it for this week's Numbers Report. Thanks for reading, and we'll see you next week.